A guide to discretionary bonus payments for employees

If it is your intention to offer a bonus to your employees, it is important that the terms of any bonus are clearly set out.

This guide is focused on discretionary bonuses as this is the type of bonus best suited to a small business and provides you with the most flexibility on how it is implemented.

Typically, offer letters and contracts of employment will provide only for eligibility to earn a bonus, rather than any express entitlement to a bonus, and will be couched in terms which provide that the operation of the bonus scheme, and the level of any award, is at the discretion of the employer (what is known as a discretionary bonus).

Once matters are properly set out in a contract or bonus scheme and communicated to employees, then it is effectively a contractual term.

You can find the relevant bonus clause best suited to your contracts of employment here

It is also important in relation to any bonus scheme that it is quite clearly set out that any bonus scheme is discretionary.

If that is not done, then by virtue of what could be called custom and practice, employees could seek to enforce bonuses.

Ordinarily, awards of bonuses will depend on the performance of the employer’s business, the employee’s work performance, or both in the preceding year.

Nevertheless, even where bonuses are described as discretionary, an employee might have a contractual entitlement to it as an implied term of the employment contract.

This might arise, for instance, by virtue of custom and practice whereby an employee receives a bonus at a particular level consistently over a prolonged period of time.

Where a contractual entitlement exists, and an employer fails to pay a bonus, a breach of contract claim may arise, or a complaint of an unlawful deduction from wages may be made to the Workplace Relations Commission.

A failure to pay such a bonus might also amount to or contribute to a constructive dismissal.

Bonuses may, in certain circumstances, be taken into account in loss of earnings awards in cases of unfair or constructive dismissal.

Any entitlement to a discretionary bonus may be subject to the employee remaining in employment (and not being in their notice period) at the time of the awarding of the bonus and not being subject to any performance measures or disciplinary sanctions.

However, there have been cases where the courts have considered a discretionary bonus to be a guaranteed bonus simply because the terms of the bonus scheme were not clearly set out in a policy or a contract of employment.

It is, therefore, very important for any employer who provides a bonus payment to have a clearly written policy which sets the rules.

In forming a view, the WRC or the Courts will be guided by what your company policy or employment contracts say.

You should also be aware that while you may enjoy the discretion to terminate a bonus scheme, this may not permit you to withhold bonuses which employees have already earned and accrued while the scheme was in operation.

Bonuses and Absence

One of the universal truths that employers face is that different employees take wildly differing amounts of sick leave.

The best policy is always to assume honesty on the part of employees, but such trust can be misplaced, and so employers often have a difficult task when deciding how to treat discretionary performance bonuses in cases where employees have been absent from work due to illness.

Should bonuses remain unchanged, be pro-rated or fall away completely once absence reaches a certain level?

Careful consideration should be given to this, as getting it wrong can have a detrimental effect on staff morale or even result in a discrimination or constructive dismissal claim.

Although a lot will depend on the precise wording of the relevant bonus scheme and historical practice, there are advantages and disadvantages of the different approaches.

1. Making no adjustment to bonuses regardless of the level of absence

Where a business operates a discretionary performance-related bonus scheme, it can cause friction amongst employees if some among their number consistently take more days of sickness leave than others, and it has no bearing on the level of bonus they receive.

How should this potentially morale-threatening situation be handled?

Making no adjustment for absence could cause resentment amongst staff and, notwithstanding the implied mutual duty of trust and confidence between employer and employee, may result in an increased average level of sickness absence across the board as even the more scrupulous of employees decide that, in view of the fact that another day off sick will not affect their bonus, their cold is, in fact, impairing their ability to do a day’s work after all.

2. Pro-rating bonuses as a result of absences

Pro-rating discretionary performance bonuses can be problematic.

First, it assumes a directly proportional relationship between performance and time spent in the office, which is not necessarily the case.

Secondly, pro-rating could be seen effectively to be turning illness into a punishable offence, which is a route that many businesses instinctively may not want to go down due to the impact it would be likely to have on morale.

It could also result in an increase in constructive dismissal claims if employees resign and try to argue that the introduction of a pro-rating policy constitutes a breach of the implied duty of trust and confidence.

Thirdly, there is the issue of how to pro-rate.

If there are 260 working days in a year, a performance bonus could be reduced by 1/260th for each sick day taken, but should pro-rating start to apply as soon as one sick day is taken or only once an employee exceeds a particular number of sick days (for example the average amongst all employees in the business)?

If a threshold is adopted, should it be announced to the employees?

Strictly speaking, there is no need to tell employees, and doing so may well only serve to approximate the existing average number of sick days taken to the newly announced threshold, as employees either treat the days below the threshold as freebie “duvet days” or, conversely, drag themselves into work (notwithstanding their highly contagious disease) so as not to exceed the threshold.

While this may be seen by some HR professionals as a useful, if somewhat Machiavellian, method of reducing sickness absence, it could increase sickness in the workplace and result in unhappy and unproductive employees.

It should be noted that adopting any sort of blanket pro-rating policy brings with it considerable risks, not least the threat of a disability discrimination claim if an employee has a disability that results in an increased number of sick days.

Employers must make reasonable adjustments to the working environment if they know (or should know) about an employee’s disability, for example, by looking at how many sick days can be attributed to the disability and then discounting them from the total number taken.

This is not always a simple calculation.

3. Removing bonuses completely once a certain threshold is reached

The most draconian option is to remove an employee’s bonus altogether once a certain number of sick days have been taken.

This approach, however, is likely to merely amplify all the problems associated with pro-rating and should only be considered in extreme cases.

To overcome this potential problem, consider introducing the rule that no bonus payment be made to any employee who has received a formal disciplinary warning under the Company’s disciplinary procedure for poor performance, attendance or absence in accordance with your absence policy, where that warning is still active on the date that the bonus is paid.

Check out our absence management policy to find out more on this topic.

Notice periods and bonus payments

The issue of bonus payments regularly arises when an employee is leaving close to or at the time of the payment of a bonus.

There are many companies who will calculate the bonus on a particular date but will then have a provision that the bonus is not paid unless the employee is in employment on the date that the bonus is due to be paid, which can sometimes be a number of months later.

An issue that often arises is what happens if an employee has put in their notice.

Take a situation where an employee must give notice of one month.

The bonus is calculated on, say, the company accounts at 31 December 2023.

The bonus payment is due to be paid on the 27th April as part of the April payroll.

The employee gives notice on the 1st April.

Clearly, they will still be in employment on the 27th of April but will be leaving a few days later.

To avoid this situation, some policies will now have a provision that not only must an employee be in employment but that if the employee has served any notice of termination or has been served with a notice of termination, even though that termination date may be after the date that the bonus would be payable, that in those circumstances no bonus is payable.

The reality is that a bonus payment is normally there to encourage employees to remain and is seen as a way of rewarding employees who are committed to the company or firm.

Conclusion

Once matters are properly set out in a contract or bonus scheme and communicated to employees, then it is effectively a contractual term.

It is also important in relation to any bonus scheme that it is quite clearly set out that any bonus scheme is discretionary.

If that is not done, then by virtue of what could be called custom and practice, employees could seek to enforce bonuses.

Some companies will have a provision that a bonus scheme applies for a particular year and that it is subject to being renewed, but there is no contractual right to have it renewed as it is a purely discretionary scheme.

There is no right or wrong answer as to how to handle the relationship between discretionary performance bonuses and their payment.

Firms with existing bonus schemes will already be informed by their wording, customs and practice.

Businesses that intend to implement a discretionary performance bonus scheme for the first time should carefully consider the effect that each of the above approaches might have on their workforce and the business in general.

And if and when you decide to introduce a discretionary bonus scheme, make sure the rules are clearly set out.